A New Boss From Outside Costs More ... a Lot More

March 14, 2007

Succession planning pays. Or, rather, it saves.

According to a new study, companies pay their chief executives nearly three times more when they hire them from outside the company than if they promote from within. In the first year of employment, CEOs snagged from the outside earned median pay of $13 million in 2005, compared with $5 million for those appointed from the inside, according to the Corporate Library, a Portland, Maine, governance watchdog.

The study was based on the compensation packages of 52 CEOs of S&P 500 companies. Thirty-two were promoted in 2005 and 20 were hired.

Paul Hodgson, senior research associate at the Corporate Library and the author of the report, said he was surprised by how many boards continue to hunt for CEO talent outside the company, considering the high costs.

"Most boards are either not doing succession planning or they aren't doing it effectively," he said, adding that there are instances—like after a corporate scandal—when it's necessary for boards to hire outside CEOs.

Corporate directors are aware of the need for better succession planning. In a separate study conducted this year by the National Association of Corporate Directors and Mercer Delta Consulting, roughly half of the corporate boards surveyed from public, private and nonprofit companies said they were "less than effective" at CEO succession, and only a similar percentage said they had a succession plan in place. Just 15% of the directors said their boards were "highly effective" in managing and developing their executive talent.